Financial Q&A: Retirement savings not the best source to pay off a mortgage

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December 31, 2007

By Steve Dinnen

Q: I have enough money in my retirement savings to pay off my home. That would decrease my expense structure and allow me to retire soon (I am 63). What are the pluses and minuses of investing the money or using it to pay off my home? I would use 25 percent of my retirement savings to pay off my mortgage, which has a 5.75 percent interest rate.

R.S., Plainfield, Ind.

A: Anthony Purpero, senior financial adviser with Partnervest in Santa Barbara, Calif., lists a number of pluses and minuses based on the number you provided:

Pluses: You're over 59-1/2 so there's no IRS penalty to withdraw from your retirement plan.

IRS tax tables state that at age 63 your standard deduction before itemizing is approximately $5,150. In your case, that means there is little or no tax advantage to carry your mortgage unless it exceeds $89,000. (A mortgage at $90,000 x 5.75% = $5,200 in interest, of which $5,150 cannot be used because the standard deduction is already given for that amount.)

Minuses: When you withdraw money from your retirement plan you owe income taxes. The more you take out, the higher your tax bill, so collecting an additional 25 percent at one time would probably push you into a higher bracket. In the example above, you'll have to take out $120,000 to net $90,000. ($120,000 x 25% = $30,000 for taxes).

Mr. Purpero also warns that liquidating a quarter of your retirement plan will have a big impact on your future income. Money in a retirement plan will compound and grow at a faster and higher rate because the taxes aren't deducted until that money is distributed to you.

Final analysis: A mortgage has a definite life or payoff date, so as long as the current cash flow is adequate then the mortgage will eventually be paid off.

Keeping the money in retirement mode working for you will significantly increase your future income. If you take a lump sum of 25 percent to pay off the mortgage, you have definitely taken away the potential for that money to grow.

Here's an idea: Instead of paying off the total balance all at once you could add to your payments. If your final payment currently is 15 years away, you could send in a little extra every month and have it paid off in a decade.